Taxing America’s Expats Away

On Sunday, the New York Times reported that record numbers of Americans living abroad have renounced their citizenship. The Times did not mention that there is new legislation being considered that would further target the incomes of expatriate Americans. The article also neglected to point out that excessively taxing citizens to the point where they renounce their citizenship has been a bipartisan affair.

Most countries only require their citizens to pay income tax for the country they are working in. A British citizen working in Germany will only pay German income tax. Americans pay income taxes for both the country they are working in and the United States. Most developed countries do not do this, but it does put the United States in the same league as North Korea, the only other nation that practices this double taxation.

Expatriates used to have ways to mitigate this burden. The tax code has some income exclusions that only began to double tax Americans if they cross a high-income threshold. Companies that send Americans abroad have the option to tax equalize their employees wages, paying extra so that the employee would only have to pay roughly the same amount that they would of U.S. taxes.

Yet Republicans and Democrats have worked to raise expatriate taxes and complicate their filing process. In 2006, Republican Senator Chuck Grassley authored a significant change to the code that increased the tax on expatriates. As The Economist noted, it was “the Republican Congress’s first renunciation of its widely trumpeted vow to block any increase in personal income taxes.” Further restrictions on foreign owned bank accounts came from the 2010 Bank Security Act.

According to Steven Relis, a Certified Public Accountant for a firm specializing on taxation of U.S. expatriates, the burden on these taxes is significant: “the 2006 tax law change increased the effective tax rate on income that was in excess of the exclusion and reduced the benefits of the housing exclusion.”

The Times described the process of renouncing citizenship as “relatively simple” but Relis points out that this ignores the scrutiny Americans face when they want to renounce their citizenship, “the IRS will assume that if a U.S. citizen wants to renounce their citizenship, that the only purpose for doing so is for tax evasion, therefore many clients opt to remain citizens.” Because of the complications, many Americans living abroad are genuinely unaware that they are not in compliance with the Tax Code.

The latest attempt to increase taxes on American expatriates is in the text of the “Tax Fairness and Simplification Act” introduced by Democrat Senator Ron Wyden and Republican Senator Judd Gregg. The bill would entirely remove the “foreign earned income exclusion” one of the few parts of the law that mitigates for double taxation.

Some may think that attacks on double taxation are just a conservative knee-jerk reaction to an attempt to raise taxes. As Jonathan Chait wrote on tax day:

Let me give you a hint, pouting rich people: We’re not falling for your bluff. None of you is really going to quit your job and deny the world your precious genius because the Democrats raised your top tax bracket to 39.6%. That’s because earning more than a quarter million dollars a year and having to pay a slightly higher tax rate than the average person is not actually such a horrible fate.

Yet in the case of expatriates, the empirical evidence suggests this is exactly what is happening! We can also assume that the majority of expatriates who do not renounce their citizenship are either eventually returning to the states, or trying to avoid the IRS.

Americans who live abroad surely owe some income tax to their mother country, the American military underwrites the global security that lets Americans work in foreign countries such as Japan and it is only fair to help support that. Yet surely we can agree that we should not promote a tax code which is increasingly discouraging Americans from remaining citizens.

UPDATED: Some commentators seem genuinely unaware that this is an issue of grave concern among the expatriate community. While there is a debate to be had over what an expatriate’s fair burden of taxes is, it is simply inaccurate to assume that this is not an issue.

When interviewed about expatriate taxes, Steve Relis, a CPA who specializes in expatriate tax returns, explained what some of the mitigating factors were:

The US offers US taxpayers an earned income exclusion for being either a bona fide resident of another country or being physically present in a foreign country for at least 330 days of a year. In fact if a US citizen working abroad earned less than $100,750 in 2009, there would be no US tax due.

This sounds acceptable, but the devil is in the details.

As noted in the article, if the Wyden-Gregg tax reform law truly gets rid of the earned income tax exclusion, a lot of these mitigating factors would likely vanish.

As other commentators have also noted, the cost of living in some European countries as well other nations such as Japan, mean that expatriates with a family living abroad may need more $100,750. This is especially true when you consider how many members of the expatriate community tend to have families and want to send their children to English speaking schools, which tend to be private and more expensive.

Additionally, the residency issues can be highly complicated. I am personally aware of expatriates who “worked” in Indonesia, but Indonesia’s own laws meant that foreigners could not be residents there, so they likely had to take up residency in neighboring countries such as Singapore. I dread to know the costs and difficulties their accountants faced while trying to figure out the Indonesian, Singaporean, and American taxes that their clients owed.

Those who want a more detailed explanation of the tax problems can be referred to this 2006 New York Times article on the costs of Senator Grassley’s changes to the expatriate tax code. Note that even in cases where an individual expatriate’s tax burden may not increase significantly, that the cost of supporting the expatriate is likely to be borne by the company that sends him abroad. This directly affects our competitiveness and discourages companies from sending Americans to work abroad.

Finally, when there is empirical evidence that more then 500 Americans have renounced their citizenship in just the first quarter of 2010, and when we know that there are many other requests being held up in consulates, surely they are responding to some negative incentives.

In 2008 The Economist also wrote about the challenges of Americans seeking to renounce their citizenship.

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53 Comments so far ↓

The US’s extraterritorial taxation is very bad idea, but it comes from the unique situation American expats face. As the article indicates, expats have diminished, or in some cases, no voting rights. This lack of representation makes them vulnerable to abusive US congressional overreach.

US tax law is confusing and complex as it is, but the laws that apply to Americans working overseas are labyrinthine in their complexity consequences (intended or otherwise). The US subjects its expats, not necessarily just to double taxation, but to two incompatible tax systems. This is put in place ostensibly for reasons of “basic fairness” as Senator Charles Grassley put it. However, the result is that Americans abroad pay substantially more tax than their on-shore counterparts.

Here is a small list of what Americans abroad experience:
1) they have no access to tax deferred retirement savings.
2) they pay capital gains taxes on their retirement savings that can and do exceed 100% and, are often paid even when there has been a capital loss.
3) they get less than half of the deductions of their on-shore counterparts, thus resulting in higher overall taxation.
4) their tax rate is based on the value of the US Dollar (which has declined 40% over the last 10 years) more so than their actual income.
and the list goes on.

This will not not go away either. With each administration and dominating party, Congress adds more penalties to Americans working abroad. The Bush administration added the last dose of pain in the TIPRA bill of 2006. While the Democrats Abroad assailed this tax hike as the “Bush Tax Hike” on Americans abroad and begged Americans abroad to get out the vote to fight these Republicans, Democrats Abroad have taken no initiative to undo that pain since taking complete power in 2009. In fact, they are introducing new legislation to remove the Foreign Earned Income Exclusion for lower income Americans working abroad and they are amping up the tax rate on higher income Americans working abroad. They have also subjected Americans abroad to the HIRE and FATCAt laws, which has made banking and reporting a nightmare.

For a growing number of Americans abroad, the best course of action is renunciation, however, there are roadblocks to that path. First, to renounce, you must have been current on your taxes for the past five years. Many Americans abroad have never been to the US and were not aware of this law until the UBS scandal, so they are now realizing that they need to renounce, but cannot do so without enormous penalties. Second, a number of laws (the most recent being HEART under the Bush administration) have made renunciation for tax reasons illegal. If the US government decide that your renunciation is tax motivated, you will be taxed on your projected net worth ten years from the date of renunciation or you will be required to file taxes for 10 years after renunciation.

Americans are boastful about their freedom. They celebrate what they consider to be unique or even miraculous – they are free. Few understand that they are not free to leave. Ironically, if they did spend some time living outside the their borders, they would realize that many countries enjoy much greater freedom that they. Perhaps, that’s what Congress is really worried about. The North Koreans simply ban emigration. The Americans use their tax system to achieve the same.